It is because banks are the only entities on Earth that can create credit (i.e. create money, since credit creation is money creation). Banks have a special role in societies. Literally, banks are able to create money out of nothing.
This activity is codified and solidified in banking laws, many of which historically originated (and evolved) from London banking laws over the past few centuries. There are many opinions and views on how banks operate, models describing banks, etc. However, at its core, banking functions and operations are based solely on banking law.
From a first principles perspective, the laws regarding banking and what “deposits” and “loans” are helps provide clarity. This is very briefly addressed on pages 7 and 8 in the paper. Your question is an excellent one because it helped me realize that I did not sufficiently cover or articulate this topic enough in the paper. Thank you for the great feedback!
In brief, banks are normally considered deposit taking institutions that lend money. Banks do not perform a pay out function of loan contracts. The bank records a new credit entry for the customer within a banks records of debts. This definition is not sufficient and obtuse when analyzing banking laws. The bank has custody of the “deposits” (not the person or entity making the deposit). Thus, a bank bail-in is contractually legally allowed in the current system (i.e. Cyprus’ bank bail-in). When someone deposits money to a bank, they are lending that money to the bank. The depositor is a creditor to the bank while the bank records the credit from its customers (depositors) on its debts side of its records (ledger). Logically, when a customer “deposits” money at the bank, it’s a record of what the bank owes the customer. The word “deposit”, as if commonly understood by many folks, can be interpreted as a subtle misnomer in this context.
All “deposits” are the money supply. Quite sensibly, bank credit guidance and analysis has been a big component of central bank operations for at least several decades (longer, perhaps depending on one’s view of history).
Banks are in the business of purchasing securities. The loan contracts are promissory notes issued by the banks. Thus, banks never actually lend money, but rather, they purchases securities, which are the loan contracts. The interesting thing is that these the promissory notes are not defined as legal tender.
In today’s current economic landscape, most of the credit creation activity is being utilized for consumption. This causes asset price inflation and consumer goods price inflation. Other aspects of the economy may be deflationary in nature. This is why the definition of credit should be disaggregated so it can addressed how credit affects non-GDP and GDP parts of the economy. For example, it could be argued that some of the recent macro data regarding manufacturer’s cost of inputs are rising at a greater rate than that which manufacturers can increase prices for their customers. Essentially, that’s the definition of a margin squeeze on a macro scale.
Another example of credit creation for non-GDP (financial asset transactions) causing a boom bust cycle through asset price inflation is the real estate market in Japan during the 1980’s to early 1990’s. From what I can gather, a big factor of that phenomena was due to an error in specific window guidance (rule set protocols) targets to credit creation allocated to the real estate market created by Japan’s central planners which incentivized unsustainable speculative lending to Japanese real estate assets. Thus, real estate asset prices increased and the asset property bubble in Japan burst causing the “Lost Decade(s)”. Some would say that such a thing could be called “moral hazard”. While I tend to agree with he spirit of that moniker, I tend to think of it simply as a insufficiently designed protocol. Window guidance, in principle, is a very useful tool for revitalizing and growing an economy; however, it lacks due to human bias, bounded rationality, and reactionary behavior embedded in its current system. An opportunity for window guidance would be to improve it wherein it’s more dynamic, transparent, and put on the blockchain with positive feedback loops (the paper addresses this briefly). I think central planners have good intentions and do the best they can to grow economies; however, policies and operations run on a very analogue systems. The biggest hurdle is that intrinsically, central planning is a de facto reactionary system wherein actions are taken after an economic event has happened. If the process involved more real-time based technology in a dynamic way, the central planning process could become more decentralized, scalable, and more bottom-up. It’d make the jobs of central planners easier with the extra ability to cooperatively acquire hindsight with citizens and other economic stakeholders through collaboration. I’m an optimist and believe that everyone wants their economies to perform sustainably well and cooperatively with other economies. We as human being are cooperative and collaborative in nature since the day we’re born and raised thereafter. It’s in our DNA. This is why I believe the use of the latin term “homo economicus” is one of the biggest intellectual faults of economics. People just don’t operate that way.
As much as there are substantial narratives around complete DeFi systems, at its core, macroeconomies and their institutions will inevitably have to foster a dynamic DeFi and CeFi hybrid model. There is no way to escape that or consider any other possible reality. Other microeconomic aspects of the economy can be purely DeFi, but that’s because it’s microeconomic which would have to transitively be plugged into the DeFi/CeFi macro hybrid structure in some way, even if passively and/or abstractly.
The gist of my paper is to foster a DeFi/CeFi hybridization of macro institutional framework whereby the decision making process and data engineering starts from the bottom-up instead of the usual top-down approach. In essence, a decentralized dynamic marketplace for productive credit allocation where the stakeholders are symbiotically the general public, businesses, and banks. The CeFi aspects would probably be more on the regulatory side of things which should be very carefully thought out. ERC1155 just happened to be a token I thought could illustrate that point in regards to how banking and economic stimulus operates. If communities and people are able to (i.e. be given the option, but not the obligation) routinely vote on where they would like credit to be allocated in their communities, economic systems can be more robust and anti fragile. There would be an increase in community banks that are built to serve their communities while also simultaneously allowing the bigger commercial banks to co-exist with them too. This would allow the jobs of central banks, governments, banks and economies at all scales to operate much more efficiently. Economic troubleshooting would be (maybe) a little simpler too. New, and simpler economic performance metrics can be transparently created, analyzed, and pipelined into ETL (data engineered) structures. There are fundamental questions and concerns regarding data privacy and protections as well; however, blockchain can help provide those elements in a trustless environment. Still a lot more work and collaboration needs to be done in this space if it is ever going to become a reality in whole or in part.
Credit creation from banks should be used for productive purposes. While “productive purposes” is a general (and debatable) thing, I tend to hope that both consumers and regulators would be able to come to some consensus in regards to what productive purposes are. It would entail defining what are financial asset transactions vs. non-financial asset transactions for sustainable business investments.
Thanks again for the great question. I know my reply is a bit long, but I wanted to take the time to illustrate my thought process so that others reading this thread may benefit too. Also, I hope this long reply helps anyone reading this thread to seek or discover any potential flaws in my reasoning. Who knows? Maybe someone out there will find an even better way to approach these sorts of topics. That would be really cool.